SECTOR ASSESSMENT (SUMMARY): FINANCE 1

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1 Country Partnership Strategy: Thailand, A. Sector Issues and Opportunities SECTOR ASSESSMENT (SUMMARY): FINANCE 1 1. Thailand has a sound and well-regulated banking system, capital market, and insurance industry offering a diverse and expanding range of financial products. However, work has mainly focused on developing systems and regulation. The financial system has been generally effective in mobilizing and channeling capital to support overall economic growth and diversification, but less effective in stabilizing household incomes, financing small and medium-sized enterprises (SMEs), and funding large-scale infrastructure investments. 2. Banking. Banking sector rebounded strongly after the 1997 Asian financial crisis. The global financial crisis of 2008 had a relatively limited impact on the Thai finance sector due to sound regulations, the funding structure of Thai banks (mostly domestic deposits), and the low exposure of banking to subprime assets. In 2011, domestic credit provided by banking was 150% of the gross domestic product (GDP). However, gaps remain in providing access to finance to moderate- and lower-income borrowers. The government is relaxing its strict restrictions on foreign investment in banking. Banking fundamentals continue to be strong, with most banks reporting high capital adequacy ratios. However, a certain portion of qualified capital is scheduled for repayment in the coming years. Accumulation of Basel III compliant capital will be needed in the near and medium term. 3. Capital markets. Equity market capitalization has increased markedly since the Asian financial crisis, from 24% of GDP in 1997 to 97% at the end of Most growth in capitalization came from already listed firms, although the number of listed firms has steadily increased. Publicly listed shares are traded through the Stock Exchange of Thailand (SET). SET also operates a market for smaller companies the Market for Alternative Investment. The SET market turnover ratio was about 85% in Local individual investors account for most trading, with trading by institutional investors limited by some restrictions on investment in equity. SET operates an active derivatives market in stock derivatives and precious metal derivatives. The agricultural futures exchange has failed to attract significant business. However, no capital market is available for promoting entrepreneurial start-ups and technological innovators. Development of the bond market accelerated after the 1997 Asian financial crisis. While government bonds still account for about 80% of all bonds issued, corporate bond issuance has been increasing. The main institutional investors in the bond market are commercial banks, insurance companies, and pension funds. 4. Contractual savings. Contractual savings (e.g., insurance companies, mutual funds, and pensions) play a significant role in fostering economic development. They provide a body of stable, informed, and long-term investors, significantly improving liquidity, providing funding for long-term investments such as infrastructure projects, and strengthening corporate governance. They are an important part of social protection given the rapidly aging population. Women particularly benefit from contractual savings as they are at higher risk than men of falling into poverty after retirement given their relative concentration in low-paid, low-skilled jobs, including in the informal sector without pension fund coverage. While mutual funds were established in Thailand in the 1970s, funds under management remained relatively small until the last 10 years 1 This summary is based on ADB Thailand Finance Sector Assessment. Manila. Available on request; ADB Thailand s Capital Market: Microfinance Sector Assessment. Manila. Available on request; ADB Thailand: A Private Sector Assessment. Manila. Available on request.

2 2 when they increased 10 times to B2,000 billion in While investments in equity have increased, mutual funds are generally seen as tax-efficient deposit substitutes and their investments have recently been mainly in fixed-income assets. Further is expected as the industry prepares for increased competition when the ASEAN economic community is established. 5. Insurance and pensions. While growing since early 2000, Thailand s insurance industry is relatively underdeveloped with a penetration rate of about 4.4% in 2011 (against a global average of 6.6%). The retirement annuity market is at an early stage of development. Thailand has no mortgage credit insurance scheme. More needs to be done to enable a wider diversity of investment allocation strategies and to provide the industry with longer-duration investments. Likewise, only 36.6% of the national labor force is protected by social insurance. Nearly 70% of older residents (5 million) have only small old age benefits as a safety net. The Social Security Act was amended in 2010 to extend protection to informal labor, but the National Saving Fund, a voluntary pension fund for informal workers, has not yet been implemented. Rates of returns on pension funds have been low because of overly conservative investment policies. Weaknesses in the pension system are a particular concern given the aging population and social disquiet about growing inequality. Throughout the contractual savings industry, efforts must be expanded to develop a larger pool of risk management professionals, including actuaries. 6. SME access to finance. Major obstacles to financing SMEs are (i) an ineffective collateral framework, particularly for movable assets; (ii) lack of SME business experience and business plans; (iii) poor information on SME credit history; (iv) high transaction costs of processing SME loan applications; and (v) strict regulations regarding loan loss provisions and credit history. SMEs have difficulty requesting credit from banks due to (i) weaknesses in information and advice from financial institutions, (ii) complexity and inconvenience of loan application processes, and (iii) insufficient collateral. The country has only a few venture capital funds; the industry has not grown due to regulatory obstacles and perceived entrepreneurial cultural differences. 7. Inclusive finance. Overall access to the formal financial system is high. About 74% of all adults have bank accounts and an additional 23% use other formal financial services. A further 2% use only informal financial products, leaving only 1% not using financial services. This access is largely the result of government policies, with commercial finance playing an important complementary role in providing access to credit and insurance, while taking the lead in providing savings and remittances. Yet, despite high formal access to financial services, many households remain vulnerable to income volatility due to limited financial assets. Substantial pockets of unmet demand remain, including populations in the northeast and about 2 million undocumented migrants who do not have access to any formal financial services. Ensuring access to finance for all will require an increase in the quantity and quality of supervised financial services, and a reduction in the cost of such services while improving consumer protection of clients and strengthening financial literacy, particularly at the village level. Households have limited access to finance for homes, with mortgage debt outstanding to GDP at only 17%. This contributes to the lack of affordable housing among poorer segments of the population. Some key issues include shorter loan tenors and higher downpayments for moderate- and lower-income borrowers. Solutions to address these challenges and to create affordable housing options are needed. 2 About 37% of formal household savings.

3 3 8. Financial skills. Several problems in Thailand s finance sector, from excessive indebtedness to poor record-keeping by SMEs due to lack of product, can be attributed to gaps in financial skills, inadequate and unreliable accounting systems, and weak consumer protection. Gaps in financial skills also translate into lack of demand for product. While many financial literacy schemes are being implemented, they are fragmented and not centrally coordinated and tracked. 9. ASEAN integration The Bank of Thailand has liberalized rules on foreign ownership of banks; six Thai banks are now subsidiaries of foreign banks. The Thailand Securities and Exchange Commission (SEC) is an active member of the ASEAN Capital Market Forum (ACMF), which comprises regional capital market regulators. 3 SEC is currently heading two working groups: Working Group on Mutual Recognition of Collective Investment Schemes, and Working Group on Cross Border Dispute Resolution and Enforcement Mechanism. 4 Overall, SEC has adopted many of the initiatives developed through the ACMF, including the ASEAN disclosure standards for equity and debt securities, and the expedited review framework for secondary listings. SEC is also actively involved in other initiatives, including supporting marketing services and the ASEAN corporate governance scorecard. SET is leading the Strategic Working Group on ASEAN Exchanges. In October 2012, SET joined the ASEAN trading link connecting with the Bursa Malaysia and the Singapore Exchange, facilitating cross-border investments through local brokers. B. Government Strategy 10. The Eleventh National Economic and Social Development Plan, highlights the need for stronger and more inclusive financial and capital markets to facilitate entrepreneurship,, and economic restructuring, and for more options for saving. 5 The plan stresses the need to improve financial literacy and provide more inclusive access to finance to low-income households and SMEs. The Committee on National Financial Literacy has been tasked to develop a national strategy for financial literacy. The plan also highlights the need for more competition, improved supervision, and better enforcement of regulations introduced under the Financial Sector Master Plan and the Capital Market Development Master Plan (CMDMP). The government aims to have the capital markets play an increasingly important role in financing the country s infrastructure development. C. ADB Sector Experience and Assistance Program 1. ADB Sector Experience 11. ADB has adopted a programmatic approach to support capital market development. Consistent with CMDMP priorities, the ADB country partnership strategy, focused ADB support for capital markets development on (i) bond markets, (ii) equity and derivative markets, and (iii) rationalization of the tax structure and regulatory framework. ADB supported the development and implementation of the CMDMP, ADB s 2010 Capital Market Development Program loan ($300 million) supported measures to strengthen regulation and supervision of capital markets, demutualize SET, and enhance the autonomy of regulators and coordination of stakeholders. Legal reforms clarified the roles and responsibilities of finance sector regulators, and strengthened enforcement capabilities and coordination. New or amended 3 The Thai SEC chaired and provided the secretariat for the ACMF from 2009 to The Ministry of Justice, Government of Thailand, cochairs the working group. 5 Government of Thailand. National Economic and Social Development Board Eleventh National Economic and Social Development Plan, Bangkok.

4 4 legislation supported under the program include the Office of Insurance Commission Act, 2007; the Bank of Thailand Act, 2007; the Securities and Exchange Act, 2008; the Financial Institutions Business Act, 2008; and the Deposit Insurance Protection Act, ADB continued to support capital market reforms through TA attached to the program. 12. ADB has supported the government in identifying and addressing critical barriers to expanding finance sector access, including financial skills and pension system reform. ADB also identified a growing need to increase access to SME financing and venture capital to encourage and entrepreneurship in Thailand. 13. The ASEAN Economic Community Blueprint, 2015 calls for freer flow of capital by strengthening ASEAN capital market development and integration. ADB supported the ACMF in developing the blueprint s implementation plan, which was endorsed at the 13th ASEAN Finance Ministers Meeting. Thailand s SEC and SET have played leading roles in implementing the plan. 2. ADB Sector Strategy 14. ADB s forward strategy for finance sector development will focus on the following main program areas: (i) Drawing on the existing strong partnership, ADB will continue to support capital market development by helping (a) develop and implement a new national strategy for financial literacy and skills (taking into account financial literacy among women); (b) promote contractual savings and the introduction of new financial products, including mortgage insurance; and (c) evaluate and develop the government s capital market development master plan. (ii) ADB will help enhance access to finance by (a) supporting the formulation and implementation of the national strategy for financial inclusion, 6 and (b) identifying appropriate finance mechanisms to address gaps in existing public and private financing of for SMEs. (iii) Given the substantial role that the Thai SEC and SET play in regional capital markets integration, ADB will seek opportunities to partner with Thailand to support regional integration and capacity building in neighboring countries with less-developed capital markets. (iv) Under its private sector window, ADB will seek opportunities to (a) improve access to finance for micro, small, and medium-sized enterprises; and for renewable energy and energy efficiency projects; (b) promote affordable and lower-income housing; (c) support nonbanking financial institutions; and (d) ensure compliance with Basel III regulatory standards. 6 ADB will carry out a diagnostic assessment of Thailand s regulatory and supervisory framework, and the institutional and human resource capacity for inclusive finance. The National Strategy for Financial Inclusion aims to (i) assist in extending financial services (including micro insurance) to those without bank accounts, (ii) strengthen the quality and diversity of products and services provided to the low-income market, (iii) identify regulatory reforms and incentives to encourage new entrants into the market (commercial or nonprofit), and (iv) establish safeguards for users of financial services (e.g., consumer protection and financial literacy). In its policy dialogue, ADB will incorporate gender dimension in the finalization of the national strategy and emphasize the importance of women in microfinance.

5 5 Problem Tree for the Finance Sector Effect: Inequality Core problem: Limited access to appropriate financial services Causes: Pension system is ineffective as a quality long-term investor and social safety net Low-income families have limited access to financial services Lack of financial product s Capital market is ineffective as resource allocation mechanism Pension coverage is low and benefit payout is not sufficient Potential unsustainability of the current social security system Lack of consumer protection and credit information system Weak regulatory framework for semiformal and informal microfinance Prudential regulations discourage risk taking and product SMEs have difficulty accessing finance SET monopoly position Difficult to raise capital for start-ups and Poor financial literacy Lack of financial understanding and restriction on investment in higher return equity markets Subsidized microfinance services by specialized financial institutions discourage competition and No mortgage insurance system and weak collateral institutions Distortion in mutual fund system discourages financial Low penetration of insurance Limited trading by local institutional investors and high trading volume by retail investors Poor financial knowledge and management skills

6 6 SECTOR RESULTS FRAMEWORK (FINANCE, ) Country Sector Outcomes Country Sector Outputs ADB Sector Operations Outcomes with ADB Contribution Increased use of appropriate financial services by all Indicators with Targets and Baselines Percentage of population without a bank account decreased by 10% by 2017 (baseline 2012: 26%, 55% are women) Pension coverage increased to 60% of national labor force by 2020 (baseline 2011: 36.6%) Outputs with ADB Contribution Improved access to appropriate financial services for all population segments Indicators with Incremental Targets National Strategy for Financial Inclusion developed by 2015 Mortgage insurance scheme established by 2016 Structure in place for extending adequate pension coverage to the informal sector by 2016 and better rate of return to investment of pension and provident fund observed Planned and Ongoing ADB Interventions Pipeline projects with estimated amounts 2013, Strengthening Financial Capability and Skills (CDTA, $0.5 million) 2014, Implementing National Strategy for Financial Inclusion (CDTA, $1 million) 2014, Support for Mortgage Insurance (PATA, $0.8 million) 2015, Social Safety Net (PATA, $1 million) Ongoing projects with approved amounts National Financial Inclusion Strategy (PATA, $1.5 million) Capital Market Development Program, Phase 3 (PATA, $0.9 million) Main Outputs Expected from ADB Interventions Pipeline projects National Strategy for Financial Inclusion implemented (with gender strategy mainstreamed) Roll-out of coordinated financial literacy program and common monitoring and evaluation framework adopted Sustainable business model for mortgage insurance developed Pension rules and regulations revised to allow for broader investment portfolio and a scheme for informal sector pension developed Ongoing projects National Financial Inclusion Strategy developed and adopted A deeper and more diversified capital market ADB = Asian Development Bank, CDTA = capacity development technical assistance, PATA = policy and advisory technical assistance. Source: Asian Development Bank staff.